The Evolution of ESG in the Institutional Space

12 Apr

The Evolution of ESG in the Institutional Space

Asset managers hoping to gain traction with consultants for their Environmental, Social and Governance (ESG) strategies need to be aware of the field’s evolution when crafting presentations and written responses, according to Reino Ecklord from NEPC and Cambridge Associates’ Kelley Shepherd.

Intent Versus Exclusion

Speaking at eVestment’s recent EI3 conference in Atlanta, both Ecklord and Shepherd noted that ESG investing has evolved significantly from the days when it meant simply excluding certain sectors and stocks from portfolios. Today, terms like “impact investing” and “mission-related investing” (MRI) better describe the variety of approaches taken by asset owners and their consultants.

Shepherd described MRI as “a conscious decision and an intent to integrate factors – be they environmental, social, governance, or otherwise – into the core of the investment process. There’s an intent around having a differentiated product to meet a client’s specific, mission-aligned need.”

Kelley Shepherd
Cambridge Associates

“Intent,” Ecklord added, “is the key word when distilling what it means when we talk about impact, socially responsible, or ESG investing umbrellas. ESG, when you take a step aside, represents non-financial factors that people are either already including as part of their investment research or are thinking about more constructively. The intent is what drives why you’re doing this; are you integrating this idea into your process to achieve goals in addition to your general risk return goals.”

Reino Ecklord
NEPC

How Asset Managers Can Best Position ESG Strategies

Managers hoping to gain traction with consultants should consider several key approaches, the panelists recommended. These include a clear description of what ESG means to the manager, how the ESG team is organized and staffed, the firm’s culture, and how portfolio managers incorporate ESG factors and risks in their investment process.

According to Ecklord, “The million-dollar question that a lot of people are trying to answer is, how can I measure the impact I’m having? We’re working more on a one-on-one basis with clients to figure that out.” Asset managers can gain traction by clearly articulating how the multiple aspects of their unique ESG approach is distilled into an investment process and subsequent portfolio.

“How and why are you incorporating ESG factors, what the goals are, and talking about concrete examples of how those are driving decisions, even if they are not completely demonstrable in performance today, I think, is critical,” he added.

An example of the need to provide a holistic description of a manager’s strategy, Shepherd said, would be, “if you say you’re an environmentally focused strategy, odds are we’re going to ask for your holdings, we’re going to run them through an industry tool to help assess the carbon intensity of the strategy, and we’re expecting that the promise is meted out in the output from the analytics at a very simple and concrete level. At the end of the day, the proof’s in the pudding when we look at your portfolio.”

Preparing for the Future and Winning Market Share

Asked how they expect ESG to evolve in the next 10 years, the panelists focused on combining multiple and evolving views of ESG into a more comprehensive framework, i.e. “the difference between simply using ESG factors as part of an investment process versus focusing your portfolio around ESG factors for a thematic ideology or other outcome,” as Ecklord pointed out.

“Figuring out how to align investor missions or viewpoints is going to be challenging.” he added.

For asset managers, moving from simple definitions of MRI or ESG at the investment process and portfolio construction levels will be challenging, but, as Shepherd pointed out, “I think the industry will be all the better for that. The more that we see portfolios that don’t tag themselves as “MRI” integrating MRI or ESG factors into their investment process, the better off we’re all going to be.”

Asset managers who have been disappointed by flows into their ESG products may have more success by shifting their focus, he added.

“I think the flows will come as some of these thematic strategies become unique components of a diversified portfolio, or a diversified private portfolio, by providing exposure to something that perhaps the client doesn’t have in their existing investments, like niche credit strategies focused around environmental themes or education focused venture strategies.”

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